The last time Australian inflation was this weak the RBA cut rates immediately, but Westpac believes this time will be different

Financial markets see a rate cut from the RBA next week as an even money bet.

Westpac’s Bill Evans believes the RBA will hold off easing policy in May despite a big Australian inflation miss in the March quarter.

He expects the RBA will only adopt an explicit easing bias, an acknowledgement that it’s likely to cut rates again.

Westpac expects the RBA will act upon that easing bias by August given the prospect for weak GDP growth and inflation and higher unemployment.

The prospect of a 25 basis point rate cut from the Reserve Bank of Australia (RBA) next week is currently deemed to be an even-money bet, according to current market pricing.

However, according to Westpac’s Chief Economist Bill Evans, one of the first prominent forecasters to call for RBA rate cuts this year, the bank will only signal that it’s likely to cut interest rates again, rather than actually delivering a preemptive policy easing in the wake of Australia’s weak March quarter consumer price inflation (CPI) report released last week.

Despite similarities to early 2016, when a weak CPI report prompted the RBA to cut Australia’s cash rate to its current level of 1.5%, Evans believes the reaction function from the RBA will be different on this occasion.

“Markets are likely to be relying heavily on the precedent of 2016 for their ‘early’ rate cut view. But there are considerable differences,” Evans said in a note released today.

One of the key differences is that Philip Lowe is now the RBA Governor, a man who has not, to date at least, demonstrated the same enthusiasm to cut interest rates in response to inflation undershoots as his predecessor Glenn Stevens did in the past, seemingly placing increased emphasis on financial stability risks stemming from the housing market.

“The housing market is much more fragile than in 2016 and we see little risk in any over reaction by housing to rate cuts as we saw in 2016 but Governor Lowe may remain cautious, for a little longer, given his strong emphasis on asset markets,” Evan said.

Along with Lowe having a greater tolerance to underlying inflation remaining below the RBA’s 2-3% target, clearly demonstrated by the fact the RBA has not cut interest rates for over two years despite inflation showing few signs of turning higher, another key difference is an absence of an easing bias from the RBA heading into next week’s meeting.

Along with the timing of Australia’s federal election on May 18, and the likelihood the RBA’s next set of GDP and inflation forecasts released on May 10 won’t be enough, in isolation, to warrant an immediate rate cut, Evans believes this will see the RBA hold off easing policy settings until later in the year.

“We think that a move next week will be a little early for the RBA,” he said.

Evans expects the RBA will cut its GDP growth forecast for this year to 2.75%, down 25 basis points from February but still in line with what many regard as being Australia’s trend growth pace, the level where unemployment and inflation is expected to remain stable.

While he sees the bank’s trimmed mean inflation forecast being revised down by a sizeable 50 basis points to 1.5% this year, he believes the RBA’s will still forecast that unemployment will fall to 4.75% next year, an outcome that will only seen the bank signal that rates are likely to be cut again.

“Those revisions will be sufficient to justify a clear easing bias which is not currently present,” he said.

However, Evans says the RBA is likely to make further downward revisions to its GDP and underlying inflation forecasts in August, including a likely upward revision on the expected path for unemployment, paving the way for the RBA to cut rates.

“With underlying inflation persistently below the bottom of the 2–3% target band, growth forecast below trend, and in conjunction with an existing explicit easing bias, the case for a rate cut would be indisputable,” he said.

“That will be sufficient to trigger the series of rate cuts which we expect for August and November.”

While there’s plenty of debate as to when the RBA will ease policy settings, there’s little disagreement, at least at this point, as to whether or not the cash rate will be lowered.

The vast majority of economists are now forecasting rate cuts while financial markets remain fully priced for the RBA to cut the cash rate by 50 basis points by February next year.

The RBA’s monetary policy decision will be announced at 2.30pm AEST on Tuesday, May 7.